USD/JPY: Energy price shock and Japan’s policy plans in focus

The major foreign exchange rates have been largely unchanged overnight with USD/JPY continuing to trade close to year-to-date highs just below the 163.00-level. The negative energy price shock remains a headwind for yen performance. Only the Swedish krona and Swiss franc have weakened more than the yen since the US-Iran conflict started back in late February. The latest tit-for-tat strikes between the US and Iran have extended into a tenth day helping to lift the price of Brent crude oil back up closer to USD90/barrel. Market participants are currently attempting to assess how long the latest disruption to energy supplies through the Strait of Hormuz will last. A report from Reuters yesterday fuelled some initial optimism after it revealed that mediators between the two sides have proposed a 10-day cease to revive the interim Iran-Us deal reached last month according to senior Iranian officials. An Iranian Foreign Ministry spokesman has since stated that “the diplomatic apparatus has been active in recent days, and ideas from some mediators have been conveyed to Iran”.  When asked about the proposed 10-day ceasefire, a Us official said that President Trump is currently focused on attacking Iran for attacking ships in the strait.         

Global energy supply risks have been reinforced as well yesterday by the threat from the Houthis, an Iran-backed Temeni group, to impose a maritime blockade on Saudi Arabia. The blockade is in response to what the group says is Saudi Arabia’s siege on the Yemeni capital of Sana’a. The group’s spokesperson said the ban on Saudi ships would be effective immediately. According to Bloomberg, the announcement stops short of fully shutting the Red Sea, but gives the Houthis room to steadily tighten the screws. It could be an important development for the oil market given that around 4 million barrels/day are currently headed to market on routes exposed to a Houthi attack.  The Houthis are initially expected to target Saudi-flagged ships before potentially expanding to vessels calling at Saudi ports, particularly Yanbu, a key oil export hub which Saudi Arabia has used an alternate channel to divert oil trade through while the Strait of Hormuz has been blocked.    

At the same time, the Japanese government finally approved an annual economic and fiscal policy plan. The approved plan didn’t include a decision on Prime Minister Takaichi’s election pledge to suspend the sales tax on food. The government will determine its policy by early August. The final document also included a footnote stating that the government leaves specific monetary policy tools up to the BoJ while respecting its autonomy. It stated “it is very important to conduct appropriate monetary policy in a manner that contributes to ‘stable price increases’”. The addition has helped to ease some concern amongst investors that the government will restrict the BoJ’s room to tighten policy further which had encouraged yen selling. Along with the fiscal plan, the government also approved the latest version of the country’s growth strategy including the key pillar calling for domestic investment of more than JPY370 trillion through to March 2041 with the aim to lift nominal GDP to nearly JPY1,100 trillion.

EUR/GBP VS. SLOPE OF UK YIELD CURVE

Source: Bloomberg, Macrobond & MUFG Research

GBP: UK fiscal policy uncertainty is attracting market attention

The pound has strengthened modestly overnight retracing some of the losses sustained yesterday after Andy Burnham was formally appointed as the new Prime Minister. There has been a bigger and more sustained sell-off in the gilt market where the 30-year yield remains around 7bps higher. The pound and gilt market sell-off yesterday was triggered by comments from Andy Burnham stating that “we’ll stick to the existing fiscal rules and use obviously any flexibility with them”. He emphasized though that “none of this is about taking risks with the economy”. Earlier in the day, the FT has run a report entitled “Andy Burnham urged to use flexibility in fiscal rules to boost investment”.  According to the Resolution Foundation, the government could mobilise an extra GBP16 billion for infrastructure investment over the coming five years due to the extra latitude resulting from a 2024 change in the definition of public debt. This could replace lost support from Britain’s withdrawal from the European Investment Bank. Andy Burnham has vowed to boost “decent infrastructure” in all parts of the UK as part of plans for “good growth in every British postcode”.

One of the first policy changes to be announced will help to reduce the cost of living. He has announced a GBP850 million plan to cut domestic energy bills by removing VAT on household electivity bills. The reduction in VAT on electivity bills from 5% to 0% is expected to lower inflation by 0.1ppt according to the government. Prime Minster Burnham has emphasized that any measures to cut the cost of living would be fully funded, and further policy measures are under consideration. The VAT cut on electricity bills will be funded by axing the digital ID scheme. Adding to uncertainty over the fiscal policy outlook was the surprise announcement that former Defence Minister John Healey has been chosen as the new Chancellor. It has fuelled speculation that defence spending will be increased more going forward given he resigned from Keir Starmer’s government citing concern over inadequate defence spending plans. He wanted the government to commit to raising defence spending more quickly to 3% of GDP by 2030. He is viewed as being on the moderate or centre-left wing of the Labour party helping to ease concerns over the risk of a much looser fiscal policy.